PIMCO, the US investment giant, has agreed to hire an independent compliance consultant and pay nearly $20 million to settle charges that it misled investors about the performance of an exchange-traded fund, while failing to value certain fund securities accurately.

PIMCO activated the PIMCO Total Return-Exchange-Traded Fund, one of its first actively managed exchange-traded funds, on 29th February 2012 and its early performance attracted substantial attention from HNW investors and the media. In the next five months, up till 30th June, according to its reported returns, it greatly outperformed PIMCO’s flagship mutual fund, the PIMCO Total Return Fund, and its benchmark index.

To help the new fund perform impressively at the start of its life, PIMCO purchased 'odd lot' positions (i.e., small-sized pieces) of non-agency mortgage-backed securities that traded at discounts to round lot positions (i.e., institutional, larger-sized pieces) and then marked those positions at the evaluated prices that were for institutional round lots (pricing vendor marks) provided by a third-party pricing vendor that PIMCO was using. The pricing vendor considered that an institutional round lot size for bonds had a current face value of at least $1 million. During the first half of 2012, as part of this strategy, PIMCO purchased approximately 156 non-agency mortgage-backed securities positions for the new fund that were less than $1 million in size. At the end of each trading day, in the SEC's words, the new fund "received a performance increase reflected by" the difference between the purchase price for the odd lot position and the higher pricing vendor mark used to value the position in the new fund (generally referred to at PIMCO as gains due to 'execution').  

PIMCO did not accurately value 43 of the non-agency mortgage-backed securities positions it purchased for the new fund that were less than $1 million in size. For these 43 positions, the SEC believes that PIMCO did not have a good reason to believe that the pricing vendor mark accurately "reflected" the exit price that the new fund ought to receive for those positions. Nevertheless, in line with its old habits, PIMCO still valued these 43 positions at the pricing vendor mark, thereby overstating the value of these securities and causing the new fund to overstate its net asset value throughout those tempestuous five months.

Right from the start, there were many indications at PIMCO that the valuations did not represent 'fair value' as stipulated in section 2(a)(41) Investment Company Act 1940. In monthly and annual reports to investors, moreover, PIMCO provided misleading disclosures about the reasons for the new fund’s performance by failing to divulge the effect of the 'odd lot' strategy and by failing to state that the performance resulting from this strategy was not sustainable as the fund grew in size. Instead, PIMCO attributed the new fund’s exceptional performance to the non-agency sector in general and prices for non-agency mortgage-backed securities that 'rose.' These disclosures implied that the new fund’s performance resulted from price appreciation in the non-agency sector, yet internal PIMCO reports indicated – and many of the drafters and reviewers of these disclosures knew – that a significant portion of the new fund’s favourable performance was attributable to initial gains from valuing odd lots at the pricing vendor mark. PIMCO also failed to disclose the existence or impact of the 'odd lot' strategy to the new fund’s board of trustees, which had inquired most explicitly about why the new fund outperformed the aforementioned Total Return Fund.

PIMCO or, to give it its full name, the Pacific Investment Management Company (a Delaware limited liability company), has about $1½ trillion in assets under managemenent. Gordon Brown, the former premier of Great Britain, sits on its five-man global advisory board of economic experts. The SEC punished PIMCO in accordance with the Investment Advisors Act 1940 and the Investment Company Act 1940. It signed the cease-and-desist order but declined to admit that it broke the law.

The firm is expanding in Asia at the moment, building distribution partnerships with financial intermediaries in Hong Kong, with a particular focus on retail banks, insurance companies and independent financial. It is forming relationships with intermediaries in China, with a strategic focus on private banks, retail banks, domestic asset managers, wealth management platforms, financial advisors and family offices.